Some argue that tax competition is beneficial by forcing governments to impose efficient tax prices on residents for the provision of public services. Further, some argue that tax competition is also beneficial by limiting the power of governments to levy taxes. Others take a different view - in a world without coordinated tax policies, governments choose sub-optimal levels of public services financed by inefficient taxes that are either too high or too low by ignoring spillovers imposed on other jurisdictions. Capital Mobility and Tax Competition draws out the most important issues of uncoordinated tax policy at the international level for cross-border transactions.
Policy choices[ edit ] According to the impossible trinity, a central bank can only pursue two of the above-mentioned three policies simultaneously. To see why, consider this example: If the central bank also wants to have free capital flows, the only way the central bank could prevent depreciation of the home currency is to sell its foreign currency reserves.
Since foreign currency reserves of a central bank are limited, once the reserves are depleted, the domestic currency will depreciate. Hence, all three Economics and capital mobility the policy objectives mentioned above cannot be pursued simultaneously.
A central bank has to forgo one of the three objectives. Therefore, a central bank has three policy combination options. Options[ edit ] In terms of the diagram above Oxelheim,the options are: A stable exchange rate and free capital flows but not an independent monetary policy because setting a domestic interest rate that is different from the world interest rate would undermine a stable exchange rate due to appreciation or depreciation pressure on the domestic currency.
An independent monetary policy and free capital flows but not a stable exchange rate. A stable exchange rate and independent monetary policy but no free capital flows, which would require the use of capital controls.
Currently, Eurozone members have chosen the first option a while most other countries have opted for the second one b. By contrast, Harvard economist Dani Rodrik advocates the use of the third option c in his book The Globalization Paradoxemphasising that world GDP grew fastest during the Bretton Woods era when capital controls were accepted in mainstream economics.
Rodrik also argues that the expansion of financial globalization and the free movement of capital flows are the reason why economic crises have become more frequent in both developing and advanced economies alike. Rodrik has also developed the "political trilemma of the world economy", where " democracynational sovereignty and global economic integration are mutually incompatible: Since under a peg, i.
An example of which was the consequential devaluation of the Peso, that was pegged to the US dollar at 0. This in turn implies that the pegging country has no ability to set its nominal interest rate independently, and hence no independent monetary policy.
The only way then that the country could have both a fixed exchange rate and an independent monetary policy is if it can prevent arbitrage in the foreign exchange rate market from taking place - institutes capital controls on international transactions.
Trilemma in practice[ edit ] The idea of the impossible trinity went from theoretical curiosity to becoming the foundation of open economy macroeconomics in the s, by which time capital controls had broken down in many countries, and conflicts were visible between pegged exchange rates and monetary policy autonomy.
InMaurice Obstfeld and Alan M.
Taylor brought the term "trilemma" into widespread use within economics. Burda and Charles Wyplosz provide an illustration of what can happen if a nation tries to pursue all three goals at once.
To start with they posit a nation with a fixed exchange rate at equilibrium with respect to capital flows as its monetary policy is aligned with the international market. However, the nation then adopts an expansionary monetary policy to try to stimulate its domestic economy.
This involves an increase of the monetary supply, and a fall of the domestically available interest rate. With no capital control market players will do this en masse.
Because the nation has a fixed exchange rate, it must defend its currency and will sell its reserves to buy its currency back. But unless the monetary policy is changed back, the international markets will invariably continue until the government's foreign exchange reserves are exhausted,  causing the currency to devalue, thus breaking one of the three goals and also enriching market players at the expense of the government that tried to break the impossible trinity.
In addition, capital controls introduce numerous distortions. Hence, there are few important countries with an effective system of capital controls, though by earlythere has been a movement among economists, policy makers and the International Monetary Fund back in favour of limited use.
As stated by Paul Krugman in A country must pick two out of three. The Mexican peso crisis —the Asian financial crisis —and the Argentinean financial collapse —  are often cited as examples.
In particular, the East Asian crisis — is widely known as a large-scale financial crisis caused by the combination of the three policies which violate the impossible trinity.
First, because of the de facto dollar peg, foreign investors could invest in Asian countries without the risk of exchange rate fluctuation. Second, the free flow of capital kept foreign investment uninhibited. Third, the short-term interest rates of Asian countries were higher than the short-term interest rate of the United States from — For these reasons, many foreign investors invested enormous amounts of money in Asian countries and reaped huge profits.
While the Asian countries' trade balance was favorable, the investment was pro-cyclical for the countries. But when the Asian countries' trade balance shifted, investors quickly retrieved their money, triggering the Asian crisis.
Eventually countries such as Thailand ran out of dollar reserves and were forced to let their currencies float and devalue. Since many short term debt obligations were denoted in US dollars, debts grew substantially and many businesses had to shut down and declare bankruptcy.Mundell-Fleming Model of a Small Open Economy Dudley Cooke Trinity College Dublin Dudley Cooke (Trinity College Dublin) Mundell-Fleming Model 1 / Reading Under perfect capital mobility the BP curve is horizontal in (i,y)-space.
We can then draw the IS and LM conditions as we did in the closed economy. Copeland uses this approach. Following Solon’s mobility model, the authors study the impacts of public investment in human capital, returns to human capital, and taxation.
The results show that better school quality and higher returns to education increase adult incomes and reduce teen birth rates for children from low-income families.
In the economics literature, the presence of capital mobility is tested alternatively by using the saving-investment correlation, interest parity condition, and finally .
tion and encourage economic growth. Labor mobility driven by economic rea- an age of capital mobility abandoned at the onset of World War I.
From to , a population in Factor Mobility and Migration. Factor Mobility and Migration. The. Factor Mobility and Migration in be. Factor Mobility and Migration. Social Network Capital, Economic Mobility and Poverty Traps† Sommarat Chantarat and Christopher B.
Barrett§ Abstract This paper explores the role social network capital might . rate economics. One of the less known is the fact that he is the father (grandfather?
godfather?) of the bipolar view Œ that is, of the idea that capital mobility creates pressure however, capital mobility does not imply the need to abandon intermediate regimes.
It is unlikely that one more paper will produce a consensus on these contested.